The CRA has for some time communicated a mixed message to claimants and reviewers in terms of documentation or evidence required to substantiate a SR&ED claim.
On the one hand, the CRA has maintained that documentation or evidence is required to substantiate a claim. On the other hand they have written that “the lack of documentary information should not discourage you from making an SR&ED claim or be considered as an indication that SR&ED did not take place, particularly in the case of first-time claimants.” (T4088, Guide to Form 661, Appendix 2). Where there is no documentary information, other “supporting information” is needed to support the SR&ED work and the related expenditures. However, the CRA provides no guidance in terms of what non-documentary “supporting information” is.
As a result experienced CRA reviewers have tended to qualify a project on the basis of a range of evidence including oral interviews, facility tours, product demonstrations, company records not generated specifically for a SR&ED claim and where they exist, formal project documentation.
The test for accepting or rejecting a claim is one balanced by the idea that the” business environment in which SR&ED is carried out (i.e. the size of the company and industry practice) will influence the nature and sources of evidence that are available to support the SR&ED claim” (T4088 – Guide to the 661).
Larger companies are expected to have more employees and more formal procedures for managing and documenting company activities and so are required to provide more documented evidence of SR&ED than smaller companies with limited resources and possibly less demanding customers. The CRA has maintained that what they require is no more than what good management practice requires. In other words, a well managed company would keep the records the CRA requires during the normal course of business.
In a draft internal Guide to Reviewers, the CRA has for the first time directed its reviewers to DENY a SR&ED claim if it LACKS supporting evidence. This directive could have huge negative implications because “a lack of supporting evidence” is subjectively determined. What does a lack of supporting evidence mean? And how can a claimant argue the opposite?
Now, it is not a question of fact whether a company performs SR&ED or not, it is increasingly a question of supporting evidence. The CRA’s advice that a lack of documentary evidence should not discourage you from making a SR&ED claim seems now to have been superseded by this new “deny” statement.
It appears, from our discussion with senior CRA managers and our review of recent guidance documents, that the CRA now requires contemporaneously generated documentation that provides a clear connection to all aspects of the claim in order to approve a claim. Their guidance to reviewers is that:
Interviews conducted by the CRA Reviewer during a site visit are intended to help determine if the claimed work meets the definition of SR&ED. However, “oral statements are not a substitute for the claimant keeping adequate documentation or other evidence.” (SR&ED Technical Review, A Guide for Claimants)
Contemporaneous documentation that is dated, signed and specific to the work performed is the best supporting evidence that you can provide. If you choose to substantiate the work performed using other evidence, you must ensure that the evidence clearly addresses the questions on Part 2 of Form T661. (SR&ED Technical Review, A Guide for Claimants and T4088 – Guide to the 661)
In its draft Claim Review Manual the CRA brings a Tax Court ruling that “Although the Income Tax Act and the Regulations do not say so explicitly, it seems self-evident that a detailed record of the hypotheses, tests and results be kept, and that it be kept as the work progresses.”( Northwest Hydraulics – Tax Court of Canada – 98 DTC 1839)
On the basis of the Northwest Hydraulics ruling the CRA has replaced its definition of ‘systematic investigation’ with a “five stage process”. Claimants now need to provide documentation that evidences progress through five-stages in each project.
These five stages are: “the observation of the subject matter of the problem; the formulation of a clear objective; the identification and articulation of the [uncertainty]; the formulation of a hypothesis designed to reduce or eliminate the [uncertainty]; and the methodical and systematic testing of the hypotheses.”(SR&ED Claim Review Manual)
According to the CRA, “Form T661 is [now] designed in such a way to try to get claimants to provide information that demonstrates that they followed this five-stage process.” In other words, if you didn’t proceed through the five stages, you fail the systematic investigation test.
It once was the CRA’s view that documentation generated during the normal course of business would suffice to support a claim. It appears now that a more formal contemporaneous documentation generating procedure is required by all claiming companies. This appears to prejudice mid-size and smaller companies where teams are less commonly found and communication is verbal as well as companies with immigrant employees whose English language skills may not mach their technical skills.
Because so much is at stake, RSG Revenue Services Group assists companies to ensure they comply with CRA requirements for SR&ED claims.
Appendix 1: List of Supporting Evidence
The list of supporting information for the financial review is all documentation:
“financial statements and records, ledgers, journals and vouchers. Source documents such as receipts, contracts and general correspondence; Cost breakdown per project for each line item in Part 3 Section B of Form T661; Cost allocation method used to allocate labour and overhead expenditures to SR&ED; Time sheets; Contracts and/or agreements related to the SR&ED claim; Logbooks or other documentation that support the SR&ED use of equipment for the period; Documentation to support third‑party payments; Supporting schedules such as reconciliation of amounts on Form T661 to the financial statements;Supporting schedules to reconcile capital expenditures on Schedule T2SCH8, Capital Cost Allowance, and Form T661 to the financial statements; Schedules to support the amount of the recapture of ITC amount; and Provincial/territorial income tax returns.”
The list of supporting information for the technical review:
Project planning documents; Records of resources allocated to the project, time sheets; Design of experiments; Design documents, computer‑aided design (CAD) and technical drawings; Project records, laboratory notebooks; Design, system architecture, and source code (software development); Records of trial runs; Project progress reports; Minutes of project meetings; Test protocols, test data, test results; Analysis of test results, conclusions; Final project report or professional publications; Photographs and videos; Prototypes, samples; Scrap, scrap records.
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